A Moment For Fiscal Courage

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One year ago, it seemed reasonable to hope that the mortgage crisis would be contained. Since then, just about everything that could go wrong has gone wrong. The crisis has spread through the financial system and is metastasizing into a global slowdown. It cries out for a bolder government response than we have seen so far. So here is a test for candidates McCain and Obama: Which of you would provide it?

When the mortgage market crashed, it was plain that billions of dollars of real estate loans would not be repaid, leaving enormous holes in financial sector balance sheets. But the beauty of global capitalism is that fresh billions can be found. The Chinese and Arab governments were accumulating savings faster than American lenders were squandering them, so it was simply a matter of transferring the cash from one place to another.

Sure enough, U.S. financial institutions promptly raised billions in fresh capital, including more than $30 billion in December and January from sovereign wealth funds abroad. As my Council on Foreign Relations colleague Brad Setser points out, this infusion dwarfed the bailout packages that the International Monetary Fund arranged in past emerging-markets crises.

But after these capital infusions, the real trouble started. It turned out that the banks had low-balled what they might have lost, so the foreign rescuers were hit with nasty surprises. Understandably, they became leery of providing further infusions. Financial institutions had to conserve capital by calling in loans. The mortgage mess became a credit crunch.